Earlier this week, Sears (click ticker for report: ) CEO Lou D’Ambrosio announced that he’ll resign from his position in February due to an illness in the family. Not so surprisingly, Sears chairman and hedge fund titan Eddie Lampert will be taking the reigns as CEO. Lampert, who merged Sears and Kmart several years ago, will be the chief executive for the first time, and as far as we can tell, he seems confident in his ability to turnaround the failing retailer. In an interview with the Chicago Tribune, Lampert cites Jeff Bezos’ success as a finance guy turned retailer leading Amazon (click ticker for report: ) as evidence that he can turn the dying company around.
Although he hasn’t done a fantastic job so far, Lampert clearly sees where retail is heading due to the innovation of the omni-channel retailer—dare we say Sears.com is actually a pretty good online shopping experience? Unfortunately, the web isn’t the problem in our view; it’s the brand. We’ve previously detailed the paltry amount of capital expenditures per square foot Sears spends compared to its peers, and this has really ruined the in-store shopping experience. Outdated stores, poorly incentivized staff, and a general lack of store traffic have contributed to weak same-store sales, which have declined 2.6% for the year on an aggregate basis (-1.6% at Sears; -3.7% at Kmart).
However, we’re starting to see some positive momentum, as quarter-to-date comps for the 9 weeks ending December 28, 2012, at Sears Domestic were a positive 0.5%, and total comps declined just 1.8%. This isn’t exactly the robust growth we’ve seen at other retailers, and while it’s certainly inflated thanks to the poor execution we’ve seen at JC Penney (click ticker for report: ) and Kohl’s (click ticker for report: ), Sears is tied to something most other retailers aren’t: appliances. Housing is likely to represent the highest potential upside catalyst for Sears, including appliance sales and possible tool sales (Craftsman). Given the higher average ticket prices of these items, same-store sales could see some material upside.
Kmart, on the other hand, seems like a dead man walking. Kmart has the same strong website as Sears, but Target (click ticker for report: ) and Wal-Mart (click ticker for report: ) are doing such a good job executing from a product and price standpoint that we do not see the company recovering. Even Wal-Mart, long-known for Sam Walton’s extremely thrifty nature and lack of investment into appearance, has been remodeling Wal-Mart’s left and right. It would take either an unexpected low-end recovery or tremendous shift in brand perception to bring Kmart back to relevancy.
Obviously, the main attraction for a Sears investment doesn’t lie in the business itself, but rather the net asset value. Unfortunately, the firm is running out of businesses to monetize, and it will eventually have to shift to its real estate portfolio, which is likely valued in excess of its current balance sheet valuation. Two big risks exist here: one, the need for JC Penney to monetize real estate which could flood the market, as well as a lack of desire from other businesses. And two, with Best Buy (click ticker for report: ) also potentially closing stores, there should be plenty of big box real estate available, with few to fill it. Dick’s Sporting Goods (click ticker for report: ), Nordstrom Rack (click ticker for report: ), and Ross Stores (click ticker for report: ) could be interested, but all three will need to see continuing strength in the brick-and-mortar space.
The question now is what is Sears worth? On a discounted cash-flow basis, we think the value is fairly hard to value, as we have a rather wide range of potential outcomes embedded in our forecast. Therefore, we’d have to see a substantial fall in value (below $27) before getting excited in the company. Given the relatively illiquid float and large short interest, an enormous move to the upside or downside is always possible.
All things considered, it’s hard not to have faith in Eddie Lampert, though he has had a few failures in the past, such as an ill-timed bet on Citigroup. We think Lampert’s initial plan was to build a holding company through Sears, using the cash flow to invest in other avenues. However, he seems to have overlooked the challenges of running a struggling retailer in a weak consumer environment. We have a lot of interest in the situation as it may impact our retail coverage universe, but we are not interested in adding Sears to our Best Ideas portfolio at this time.